Explanation

To determine the effect on EPS, we need to compare the after-tax cost of debt with the earnings yield:

Earnings yield = EPS / Price per share = $3 / $40 = 7.5%

After-tax cost of debt = 7%

Since the earnings yield (7.5%) is greater than the after-tax cost of debt (7%), the share repurchase will be EPS accretive.

Calculation logic:

• The company is borrowing at 7% to buy back shares that are earning 7.5%
• This creates positive financial leverage
• The interest expense is less than the earnings being eliminated
• Therefore, EPS will increase

Key concept: When earnings yield > after-tax cost of debt, share repurchases are EPS accretive.